Most employers who sponsor 401(k) plans for their employees, especially small to mid-size plans, are uninformed about plan design features and how to modify plan design to make their plans work better. By “working better” is meant working better for both the plan participants and the employer sponsoring the plan.

The purpose of this article is to elevate the awareness of the connection between a plan participant’s quest for retirement readiness and the plan sponsor’s role and responsibility as intended by government regulations.

Below is a list of observations followed by relevant questions that plan sponsors should be able to answer. Appropriate answers will result in an improved 401(k) plan that will fulfill the intended purpose of the plan and assist the plan sponsor with fulfilling their fiduciary duties. Because the answers are extensive, no answers are provided here. They can be gotten by contacting the author at the address and phone number provided at the end of the article.

According to The Employee Retirement Income Security Act of 1974 (ERISA), the purpose of a 401(k) plan is to provide employees with an employee benefit that will give them the opportunity to accumulate assets that will yield income during the employee’s retirement years.

The plan sponsor’s fiduciary duties include:

Duty of loyalty, which means performing all duties solely in the interest of and for the exclusive benefit of plan participants and their beneficiaries.

Duty of exclusive purpose, which means operating the plan with the exclusive purpose of providing benefits to participants and their beneficiaries and to do so while paying only reasonable expenses from plan assets in light of services rendered to the plan and plan participants and their beneficiaries.

Duty to act prudently, which means acting as a “prudent expert” with the “care, skill, prudence, and diligence – – – that a prudent man acting in a like capacity and familiar with such matters would use . . . “ (ERISA Section 404(a)(1)(B)). Key words here are “expert”, “prudence”, “diligence”. These key words mean:

Hiring experts when the plan sponsor does not have experts of their own.

Establish processes and procedures that will yield prudent decision-making processes. This is known as “procedural prudence”.

Exercising diligence so that there is written proof of conducting “procedural prudence” through written documentation.

Duty to diversify investments, which means that merely selecting investments for participants to use for constructing a portfolio for their account is not enough; the plan’s investments must provide a diversity of investments sufficient to allow plan participants to select investments so as to minimize the risk of large losses.

Duty to follow plan provisions, which means the terms of the plan’s governing documents must be followed as well as the terms of other plan-related documents to the extent that those provisions do not violate the provisions of ERISA, and are applied consistently and in a non-discriminatory manner.

Below are the observations and questions relating to various plan matters:

PLAN EXPENSES:

Observation: One of the fiduciary duties of the plan sponsor is to pay only reasonable expenses from the plan’s assets. In addition, there is the duty to minimize plan expenses overall. Generally, plan expenses decline as the size of plan assets increases and as the average size of the participants’ account increases. Lower fees and expenses generally translate to higher net investment performance and growth in assets.

Question: What procedures are you doing to make certain that plan expenses are “reasonable”? Do you have a process and procedure for evaluating and benchmarking fees and expenses?

Question: What procedures are you doing to reduce plan expenses through growing plan assets and through actions that will assist in increasing the average size of participant accounts?

Question: Since fees and expenses of the plan are expected to be reasonable in light of services provided, what procedures are you doing to make certain that the services provided meet the Department of Labor (DOL) guidelines that services must be:

Necessary for the operation and administration of the plan, as well as sufficient to successfully operate and administer the plan to fulfill its intended purpose.

Provided for reasonable fees in light of the quality and scope of services rendered.

Provided under a contract or arrangement that has reasonable terms.

PLAN PARTICIPATION RATE:

Observation: Participation in the plan by eligible employees is an indication that employees understand the workings of the plan, appreciate the opportunity to participate by contributing to their account within the plan, and are pro-active in their own retirement planning.

Question: What plan design features have you adopted that will increase the likelihood of eligible employees participating in the plan?

Question: What resources and services are you providing that will likely lead to participants participating in the plan.

III. PARTICIPANT SAVINGS RATE:

Observation: The rate of savings is one of the major factors that determine whether or not a plan participant will achieve their retirement income goal. Research has shown that plan sponsor activities have been influential in improving the participant savings rate.

Question: What plan design features have you adopted that are likely to result in an increase in the savings rate of plan participants?

Question: What additional services and resources have you provided to plan participants that are expected to result in an increase in the participant savings rate?

PLAN LOANS BY PARTICIPANTS:

Observation: Plan loans have both positive and negative effects on the plan and plan participants. Positive effects include making funds available to plan participants prior to retirement for financial need without income tax liability on the loan proceeds withdrawn from their current account, and encouraging plan participation by eligible employees who otherwise would not contribute to the plan due to lack of access to their funds prior to retirement. Negative effects include removal of investable assets from the participant’s account which results in less plan assets, smaller average account size, and higher plan expenses, and exposing other plan participants to making excess contributions to their plan account and experiencing the adverse tax and financial consequences of having made excess contributions.

Question: If you believe that plan loans should be allowed as a plan feature, then what plan design features have you adopted as a means of reducing the negative effects that plan loans might have on the plan and other participants in the plan?

Question: What resources and services do you provide that is likely to result in increased comprehension about plan loans?

INVESTMENT FEATURES – – RISK AND RETURNS:

Observation: One of the duties and responsibilities of the plan sponsor is to provide to plan participants a diversity of investment choices so that the risk of large losses can be avoided. Another duty is to manage expenses and fees paid from plan assets and pay only reasonable fees and expenses. Another duty and responsibility is to select and periodically monitor plan investments and investment providers. Reduced investment expenses generally results in increased investment returns and greater accumulation of assets to generate higher income during retirement. The ultimate goal is to produce a retirement income level sufficient to support the plan participant’s desired standard of living during retirement.

Finally, certain investment types are considered most suitable for investment diversification, especially for plans that permit plan participants to select investments for their own account.

Question: Which processes and procedures are you employing to make certain investment expenses are reasonable?

Question: Which processes and procedures are you employing to select and periodically monitor plan investments and investment providers?

Question: Which plan design features have you adopted that will provide an opportunity for plan participants and their beneficiaries to generate predictable and stable income during retirement?

Question: What services and resources are you providing to plan participants that are likely to increase their knowledge, awareness and confidence regarding investments, retirement planning, and achieving retirement readiness?

Question: What services and resources are you providing to plan participants that will give them the opportunity to make informed decisions about the management of their retirement account.

Question: What investment types are you providing to plan participants that will assist them with reducing the risk of large losses?

MINIMIZING FIDUCIARY PERSONAL LIABILITY:

Observation: Plan sponsors and other fiduciaries who retain the right to manage plan assets themselves also retain all personal liability for any loss or underperformance of plan assets. Facts and circumstances will determine the extent of liability, if any, resulting from their investment decisions. They are subject to the same fiduciary duties and responsibilities as described above. The DOL offers a special safe harbor from personal liability to plan fiduciaries who permit plan participants to select investments for their own account. This safe harbor is found in Section 404(c) of ERISA. The 404(c) statute is relatively short and, like other statutes, is not simple reading. The theory behind this statute is that if plan fiduciaries provide the plan participants with the opportunity, resources, information and services to enable plan participants to take “control” of their account in the 401(k) plan, then the plan participants will likely have the intended opportunity and improved ability to make informed decisions regarding the management of their accounts and are more likely to realize better investment performance than participants who are not provided with this opportunity. In exchange for providing this opportunity to plan participants, the liability and responsibility for investment results is shifted from the plan sponsor and other plan fiduciaries to the plan participants.

The provisions of the ERISA statute along with DOL regulations, advisories and notices, and numerous court decisions have made it clear that for plan participants to attain “control” of their 401(k) accounts requires more than just allowing them to select investments for their account. It requires more than thirty related processes, procedures and fiduciary actions to be completed by the plan sponsor and other fiduciaries. Other fiduciary duties and responsibilities must still be performed by plan sponsors and other fiduciaries, including selecting and monitoring of investments and all service providers, responding to requests from plan participants for information and services, avoiding prohibited transactions with parties-in-interest, following the principles of procedural prudence, and fulfilling the duties of loyalty, exclusive purpose, prudence, diligence, diversifying investments, and following all plan documents.

Electing to have the 401(k) plan treated as a 404(c) protected plan is not mandatory. A voluntary election is simple to do. Given the transfer of personal liability to plan participants for investment performance it is a wonder why all 401(k) plans have not elected to be protected by the 404(c) statute. While it is true that completing less than the more than thirty related processes and procedures can result in loss of the safe-harbor protection (see ENRON Court Case and case of KANAWI v. BECHTEL), employing experienced and competent experts familiar with Section 404(c) of ERISA should result in success at achieving the desired protections. NOTE: The 404(c) statute applies to any individual account plan, not just 401(k) plans. This includes profit sharing plans, money purchase pension plans, and similar defined contribution plans.

Question: Have you elected to have your 401(k) plan or similar individual account defined contribution plan treated as a 404(c) protected plan? If not, why not?

Question: If you have elected to have your 401(k) plan or similar individual account defined contribution plan to be treated as a 404(c) protected plan, then what plan design features have you adopted that will assist plan participants with achieving retirement readiness?

Question: If you have elected to have your plan treated as a 404(c) protected plan, then what resources and services have you provided that will assist plan participants with making informed decisions about the management of their accounts.

Question: If you have elected to have your plan treated as a 404(c) protected plan, then what processes, procedures, and aspects of procedural prudence have you installed and follow that will assist plan participants to take control of their account and in making informed decisions about the management of their accounts and to achieve retirement readiness?

VII. CONCLUSION:

The terminology now being used to describe a plan participant’s effort to achieve financial sufficiency in retirement is “retirement readiness”. Engaging in the planning to achieve that outcome spans both the period of assets accumulation and assets decumulation (converting assets into income). The plan participant has an obvious role in planning for retirement readiness in that they must be proactive in joining the plan and contributing to the plan. What is not obvious is the role of the plan sponsor and other fiduciaries in providing an opportunity to plan participants for achieving retirement readiness. Plan sponsors and other fiduciaries are rewarded with reduced personal liability when they take advantage of safe harbor protections of ERISA Section 404(c). If plan sponsors elect to take advantage of the safe-harbor and perform the duties, responsibilities and actions that qualify them and their plan to benefit from the safe-harbor, then plan participants are likely to enjoy significant advantage towards achieving retirement readiness compared to participants in plans where the safe harbor has not been elected. Expert plan advisors familiar with the Section 404(c) provisions and the interpretation of its provisions can assist plan sponsors in successfully completing the requirements of that very important statute.